Business owners and financial managers need to control inventory levels. Establishing the right inventory level by item for your small business is a crucial success factor. This article will explore:
Small businesses often find inventory management challenging. Finding the right amount of inventory keeps these business objectives in balance:
A Just-In-Time inventory system (JIT) is a pull system based on near-term demand. Just-in-time is accomplished by issuing a purchase order with a delivery due date that closely matches customer or manufacturing schedule needs.
The result of faster inventory turnover is increasing ROI and improving cash flow by not having too much cash tied up in inventory, and better matching the timing of customer demand. You can calculate inventory turnover, as follows:
Divide the cost of goods sold from the income statement by average inventory from the balance sheet (which is beginning inventory balance plus ending inventory balance divided by 2)
That’s a key question. Tracking inventory turnover and usage by product, item, and location can help you establish how much is too much inventory. An accounting and inventory management software can help you control inventory levels in relation to the demand for those items.
To determine how much inventory you need, you need to look at the following areas:
It depends on how much excess inventory that you have. Generally, having too much inventory is considered bad. But it depends somewhat on your situation.
If inventory doesn’t sell, it may be subject to classification as excess inventory or obsolete inventory, requiring a write-down to the actual worth of the inventory and write-off versus the amount recorded on the books for these inventory items. GAAP accounting standards require setting up a reserve, also known as an allowance, for excess inventory and obsolete inventory (if the amounts are material).
By lowering the price of inventory sold to customers, you may be able to reduce the amount of excess inventory in stock. That’s better than writing it off completely.
If you have too much inventory, you may need to spend more on insurance and storage space. The goods can be damaged, lost, or stolen. Cash flow may become difficult if you can’t turn over the inventory quickly to complete the cash conversion cycle. If you’re able to obtain additional financing to cover the cash shortfall, your business would incur extra interest expenses. There’s more business risk.
On the other hand, if you have an unexpected rise in demand and you have the right items in inventory, then having too much inventory would be favorable. You wouldn’t need to buy products to sell the extra items, you could deliver the order quickly to the customer, and the customer would be pleased.
One of the essential jobs for small business owners and financial managers is inventory management. Usually, having too much or too little inventory creates business problems. Having the right accounting software to help you manage that inventory is essential. ZarMoney software offers advanced inventory management capabilities to help you determine and maintain the ideal amount of inventory by item, product, and location for your company.